We live in a world largely driven by hysteria. In financial circles hysteria is fuelled by things like Japan’s reactors going nuclear or oil leaks in sea bed off the coast of North America. That hysteria swings prices and allows us all to overlook the substantive issues. Instead we focus on panic, inspired to make us do the wrong thing.
Nothing is more like this than AT&T and the Giant Peach ‘ in this case the Peach is Deutsche Telekom’s T-Mobile, the fourth largest US cellular operator. Very juicy.
Whichever way you look at it, this is a fairy story, hence the title. Why is it a fairy story? Because it should remain largely fiction ‘ that is unless investors can spread hysteria and panic over what will happen if this deal doesn’t happen. And they will try. If it does happen, it will push Verizon to seek its own equivalent deal, perhaps a bid for Sprint, in order to keep up, so either way it has changed the landscape of US cellular, whether it goes ahead or doesn’t.
For those not around long enough to remember, AT&T was once very, very big with $155 billion in assets, it was compared with General Motors, Mobil, and Exxon, but was actually larger than all three put together. And since then two have in fact been put together (Exxon and Mobil ‘ remember Mobil not mobile) and the other has been largely shown to be an asset only 50% of the time, the rest of the time it is a liability.
But beginning in 1980 it took a four year process to break up AT&T into 22 separate operating companies and a long lines business, which in the end, turned out not to be viable on its own. The rationale of the breakup was to escape the 1956 Consent decree whereby it had to keep out of data processing businesses. The 22 operating companies set about re-forming into one (or two) as fast as possible, rather like the Sandman every time Spiderman smashes him apart.
Today if that consent decree was still in place it might prevent AT&T from offering data services, possibly including any form of broadband, but at the time it was presumed that AT&T wanted to be like IBM and have a global IT systems and services operation – something it tried after it acquired NCR, but failed at abysmally. The reason for that failure was that it had forgotten how to compete on an equal footing, something that has never been a strong point of AT&T since it was formed ‘ it has always viewed its role to be a nationwide monopoly ‘ and has been trying to get back to this status since the breakup. It has nearly made it.
If you think that a merger between Verizon Wireless and AT&T Wireless would give it around 180 million accounts, out of 290 million in the US, then that’s pretty much what AT&T is after and since even the most big business loving republican wouldn’t countenance that particular deal (although never say never), AT&T has to get there by hook or by crook, hoping that one day the political climate would arrive where it would be allowed to merge back into Verizon to create a national US monopoly in both fixed and wireless networks, once again.
There is a lot of nonsense talked about the rules which prevent this, and most American’s recoil at the very term ‘anti-trust.’ They hate the idea of artificial, government controlled limits being placed on companies which are trying to generate vast amounts of money through market control. It’s a culture thing. But without Anti-trust legislation, large organizations just pretend to be ‘innovating,’ usually in neighboring markets to those they already dominate, and can then tie up that market simply by cheating.
All the rules have been around for a while though, embedded as they are in the Sherman Anti-Trust Act which was passed in 1890 (‘the big problem is bigness’) the Clayton Anti-Trust Act of 1914, the Robinson’Patman Act of 1936 and the Hart’Scott’Rodino Antitrust improvements Act of 1976, the last one being the most significant in this case, designed to prevent companies rushing through mergers which will result in less competition, using a premerger notification program, which will now come into play for this deal. AT&T has done its utmost to seal off complaints about this deal, presenting it as a ‘fait accompli,’ with a huge multibillion cost of unraveling it. AT&T CEO Randall Stephenson, has pinned his colors to the mast with this one, if it goes down, so does he.
There are many examples of major companies cheating. They may tie up the world’s supply of a not too widespread commodity (like Bananas), paying next to nothing for them, and then raise the prices over time until costs are virtually nothing compared to income. They can tell their logistics chain that if they also supply your main rival (or any rival) you will use someone else and bankrupt them. They can force prices down to below cost in the same way or can do the same to retail outlets or any other route to market, demanding they don’t carry competitors. They can agree among 3 or 4 other leading players in the market never to go below a certain price. All of these things are cheating and they all hurt consumers, but it is only obvious when they are found out.
In technology markets you can add something for free which cost a lot to make (like a piece of software such as a media player) in a process called bundling. Bundling is a fine strategy most of the time, but it is a way of decimating rivals when you are a monopoly or you are close to being a monopoly.
So while this week Verizon and all the cellular companies will be sitting behind closed doors thinking about this deal and how to respond to it, there is one group we at Faultline have some sympathy with ‘ the pay TV operators, which have already identified their biggest pinch-point in the future, and that’s when genuine Quad play services are brought to bear against them.
We have already seen the ‘peekaboo’ economic trick that both Apple (DRM lock in) and Netflix (we’re only renting DVDs ‘ whoops now we’re giving away free online video) have pulled in other markets. This is fine because neither of them began from the point of view of having a monopoly. But subsidizing from a monopoly position, especially in a market which is not too competitive, is the one surefire way of stealing market share in a neighboring market.
Ask any consumer what he thinks of those brands and he will wax lyrical for half an hour, but see how suspicious rival operators will become as soon as their names are mentioned as a partner. The PC operating system lock-in that Microsoft engineered has caused it no end of trouble ‘ people either hated Microsoft or refused to work with it, in virtually ALL neighboring markets. And in every business it has entered it has had to plow $billions into the setting up of the business, in an attempt to scale. This is true of Xbox, Mediaroom, Mobile, Zune and MSN, with only one of these ever being profitable for any length of time.
So by AT&T taking over T-Mobile and adding 33 million cellular subs to the 90 million or so it already had, changes many equations in cellular, in devices, in fixed line architectures and in pay TV, not to mention WiFi for cellular and entertainment offload.
Just imagine yourself as the CEO of this newly merged enterprise, and think what weapons you might unleash? Would you begin offering the iPhone and other top of the range, T-Mobile exclusive Android devices on both networks? Would you offer T-Mobile customers a cheap route into U-Verse IPTV? Would you offer free WiFi to every T-Mobile customer at renewal. Would you offer a free iPad/Motorola Xoom for every new U-Verse TV broadband customer you acquired? Would you offer to beat the bundled price of ANY cable company in your footprint in the US?
Better still why not offer to match ANY cable triple play offer, but add one cellphone contract – free. When do these stop becoming inviting consumer offers and become instead anti-trust violations? It’s tough to say, but once AT&T has say 50% of the US cellular market, then any offer which uses cellular to subsidize another service, would come close to being anti-trust. And AT&T probably already has 50% in terms of revenues, and is not far off it in terms of customers, maybe one more year of marketing, maybe two.
So yes AT&T will talk about how competitive US cellular remains after this deal and it will point to Lightsquared and Clearwire and Sprint (all of which might disappear within a year of this deal being done), as well as Verizon and 1,000 tiny local incumbents, as proof. There is even one cable operator building its own LTE network and another building out contiguous WiFi cells across New York. There may even be an argument that the cable operators can bolster either Sprint or Lightsquared (or both) by becoming MVNOs, and there is news this week that this will happen. But is all that realistic?
What AT&T is selling to investors is the fact that it will make $ billions in savings every year once the two networks are integrated, but what it is staying quiet about is that this is one more step towards a US wide Fixed/Mobile monopoly and that this step takes it to monopoly power in one fell swoop.
With savings like that, what if it spent them all on subsidizing the U-Verse offering? It could hide that within its finances easily enough and with a $3 billion a year subsidy, how long before it applies sufficient fixed line pricing pressure to cable companies to halt their growth entirely. Or shrink them.
Cable has its much vaunted DOCSIS 3.0, but what is shifting customers in broadband is the monthly price for a decent broadband service, the throughput right now is immaterial once homes are above 20 Mbps.
And it could take much of the T-Mobile margin right now and use it to subsidize a 4 way offer to T-Mobile customers, making fixed voice, broadband, TV and cellular service combined, virtually irresistible in pricing terms.
One of the mistakes that cable has made in the past has been charging such different prices in different territories, so it can hardly cry foul when AT&T does the same to match it, which could lead to a focused subsidy used to take out one particular cable operator (if they are a Cox customer they can have broadband free tell them). Is that illegal? Of course it would be, but only after AT&T acquired T-Mobile, not before. Which is why regulators have to think about it BEFORE the deal is concrete and why AT&T has made it look so much like a done deal.
AT&T would have the market power not only to pick off cable, but to pick off cable’s allies. There has been a lot of words spent on the amount of spectrum the merged entity would have, and yes it would have a lot ‘ enough to take on Clearwire, which once boasted that it has 100 MHz in most territories. But Clearwire has been trying to sell off some of that spectrum, purely so that it has funds to build out the regions it has targeted. A company that has access to plenty of funds to build out, and the same amount of spectrum to build in as Clearwire, which has the buying power already to demand device economies of scale and to sign exclusives, will be able to clean up.
While we accept that the Clearwire network is fundamentally more spectrally efficient, because there are so few telephony capable WiMAX networks about the world and that LTE is on the launching pad for about 90 operators around the world, that means LTE devices will be fundamentally cheaper. We are fans of the WiMAX technology, but we were fans of many technologies which have failed and market economics sometimes behaves that way ‘ some of the DEC operating systems were better than Unix, but Unix prevailed, and some of the Unixes were better than Windows NT, but Windows NT carved a leading market share. Marketing or positioning or sentiment or route to market or timing, can all play a part in how technology evolves and in our view the role of WiMAX was to take the WiFi model and make it carrier class, and force LTE out into the open probably a full five years before it would have emerged. And having done that, it will remain a viable technology, but not for mass market communication ‘ not for something the which the majority off consumers can hold in their hands ‘ because LTE was built in WiMAX’ image, using OFDM.
AT&T will come to market post T-Mobile absorption, with all the technology benefits that Clearwire had, as well as carrier aggregation technologies to harness all of its spectrum from a single device ‘ circa 2013, and it will be massively compelling and its devices will likely be so specialized they may not be usable on other US networks.
We could be philosophical about this and say that the cable companies had their day while the giant slept. During the 80s and 90s the telcos were asleep and not investing, trying to set the political agenda for their re-emergence into the light of monopolyhood. And this allowed the cablecos to catch up somewhat, lay their cable, develop digital technologies, speed up their broadband, and pay off (some of) the debt they built up doing this.
So from the verge of the world being on the edge of Google’s ‘open networks’ where devices can be bought at retail, and used on multiple networks depending on today’s offer, we find ourselves, in the US at least, with what might be diminishing cellular openness.
Does that mean cellular device subsidy will continue to be with us in the US? Or could it be that AT&T, once it takes 50% of the US cellular market, will be seen as a monopoly which it is not safe to allow to subsidize devices at all. We know everyone will say ‘how ridiculous, that’s not going to happen’ ‘ well it happened for a while in both Japan and Korea, for much the same reason – operators could not subsidize devices by law.
Handset subsidies are a great way to hide the true state of where your profit comes from and goes and just what your network is making for you, and whether or not you are behaving as a monopoly. AT&T would surely die as a cellular player if it was banned from subsidy and others allowed to carry on. Of course in the us this would never happen, but it should IF the US allows the deal to go ahead, which is why it mustn’t.
What next? Should set top subsidy be prevented in U-Verse Pay TV, just because of instead of being paid for out of future profits, it is coming out of cellular margins ‘ one monopoly being used to create another? It’s a very good question and it has to be answered before the deal is approved.
Many in the US (though nowhere else) will argue that there would be more innovation if Anti-Trust laws did not exist, and to a certain extent they may have a point, but not the point they think they have. If cartels were allowed to price fix, then services like TV and cellular would cost the earth and then when an alternative internet based technology came along there would be innovation, embraced on a grand scale. But no company is going to spend on R&D if it doesn’t have to and competition is the only thing that ensures this.
The whole idea of anti-trust is that it is a process which forces large companies to employ natural market pricing and not attempt to cheat. You would think, from the rhetoric of the Obama administration, that this is open and shut ‘ the deal will not go ahead, unless of course the craziness of the past few years, the Oil wars, the debt crisis, the uncertainties around European debt, the fall of the Egyptian regime, Libya and the real reverberations from Japan’s earthquake, creates that kind of hysteria which lets us overlook the substantive issues and instead hope for a single solitary, BIG news story ‘ like embracing this merger.
It was thought that T-Mobile, the giant peach, was in fact a rotten fruit, but actually it may just have become juicy enough for AT&T, the big friendly giant, to eat. And we all know that America loves a fairy story.